Vernoia, Enterline + Brewer, CPA LLC

Archive for March, 2016

The IRS has provided penalty relief to educational institutions that provide Form 1098-T, Tuition Statement, to students and the IRS for the 2015 calendar year, where the Form 1098-T is missing the student’s taxpayer identification number (TIN) or has an incorrect TIN. The relief is not available to others, such as insurers, who file Form 1098-T, or to servicers of student loans, who must provide Form 1098-E student loan interest.

Higher education institutions must provide taxpayers with statements of qualified tuition and related expenses either paid to the institution or billed by the institution. The statement must include the TIN of the student. Students or their parents can use the information to claim tax benefits such as the deduction for tuition and related expenses or the American Opportunity Tax Credit. Education institutions may be liable for penalties under Code Sec. 6721 or 6722 if they fail to provide correct and timely statements to the IRS and to the student, respectively.

In 2015 legislation, Congress relieved educational institutions of penalties for filing incomplete or incorrect statements, if they certify that they complied with IRS procedures for obtaining the TINs. This relief applies to statements and returns provided after December 31, 2015. The IRS reported that it has not made the necessary changes to reflect this change in the law. Instead, the IRS will not impose penalties under Code Sec. 6721 or 6722 on an educational institution that timely provides 2015 Forms 1098-T in 2016 with missing or incorrect TINs.

The overall individual audit coverage rate continued its steady decline in recent years, the IRS reported. The audit coverage rate for total individual returns for fiscal year (FY) 2015 was 0.84 percent, compared to 0.86 percent in FY 2014 and 0.96 percent in FY 2013. In contrast, the audit coverage rate for all types of businesses increased slightly, from 0.57 percent in FY 2014 to 0.60 percent in FY 2015. The Service also reported in February that examination revenue fell as did the number of employees engaged in collection and enforcement work.

Individual Returns

While the audit coverage rate for all individuals fell in FY 2015, the audit coverage rate for returns reflecting income of $1 million and higher increased from 7.50 percent in FY 2014 to 9.55 percent in FY 2015. In comparison, the audit coverage rate for returns showing incomes of $200,000 and higher fell from 2.71 percent in FY 2014 to 2.61 percent in FY 2015. The audit coverage rate for returns reflecting incomes of less than $200,000 dropped the least, from 0.78 percent in FY 2014 to 0.76 percent in FY 2015. As in past years, the number of correspondence exams far exceeded field exam, although the number of correspondence exams fell below one million for the second consecutive year.

Business Returns

S corporations and partnerships saw increased audit coverage rates in FY 2015. The audit coverage rate for S corporation returns rose from 0.36 percent in FY 2014 to 0.40 percent in FY 2015. The audit coverage rate for partnership returns showed stronger growth, from 0.43 percent in FY 2014 to 0.51 percent in FY 2015. However, the audit coverage rate for small corporation returns (assets under $10 million) fell from 0.95 percent in FY 2014 to 0.92 percent in FY 2015. Large corporation returns also experienced a drop in audit coverage, from 12.23 percent in FY 2014 to 11.15 percent in FY 2015.

President Obama signed in February the Trade Facilitation and Trade Enforcement Act of 2015 (H.R. 644). The comprehensive trade and customs bill includes an increase in the penalty for failure to file a return.

Penalty

The failure to file penalty is five percent of the unpaid tax shown on the return for one month, with an additional five percent for each month or part of a month that the failure continues, up to 25 percent. For taxpayers who fail to file their returns more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. The Achieving a Better Life Experience Act of 2014 (ABLE Act) provided for inflation adjustments for certain penalties, including the fail to file penalty, applicable to returns required to be filed after December 31, 2014.

The IRS may abate the penalty for reasonable cause. Generally, this means that if a taxpayer exercised ordinary business care and prudence and was nevertheless unable to file a return, the resulting delay may have been due to reasonable cause. However, every taxpayer’s situation is unique. Some examples of reasonable cause include, but are not limited to, the death or serious illness of the taxpayer or a member of the taxpayer’s immediate family; failure to file resulting from a fire, casualty, natural disaster, or other disturbance; or reliance on erroneous advice from the IRS.

Trade Act

The Trade Act provides that if a return is filed more than 60 days after its due date, then the failure to file penalty may not be less than the lesser of $205 or 100 percent of the amount required to be shown as tax on the return. The increase under the Trade Act is effective for returns required to be filed in calendar years after 2015.

The New Jersey Division of Taxation has revised TAM-13, originally issued February 24, 2011, to include a new example in the listed exceptions from the interest add-back requirement of the corporation business tax. Further, TAM-13R provides a list of five grounds for claiming that the disallowance of the deduction would be unreasonable. Generally, corporations are required to add-back interest expenses that are deducted as an expense and paid to a related member. However, in New Jersey there are three statutory exceptions to this requirement. Under one of these exceptions, the ‘”unreasonable” and “alternative apportionment method” exception’, a new example has been added. The new example stems from the 2014 decision in Morgan Stanley & Co. v. Director, Division of Taxation. In Morgan Stanley, the Division had denied the taxpayer’s claim for deduction of related party interest add-back under the corporation business tax on the basis that the “unreasonable exception” requires that the corporation pays tax on the interest income in another state. TAM-13R states that the court held the Division’s denial of the “unreasonable exception” on this basis alone, was not supported by the statute as the statute did not contain this requirement. Further, the court stated the Division had not adequately considered the totality of the taxpayer’s facts and circumstances in its analysis of the “unreasonable exception”.

The revised TAM also highlights that in Morgan Stanely the court noted that based upon the legislative intent in enacting the unreasonable exception, a taxpayer’s documentation of the below situations may provide the grounds for claiming that the disallowance of deduction would be unreasonable:

(1) Unfair duplicative taxation;

(2) A technical failure to qualify the transactions under the statutory exceptions;

(3) An inability or impediment to meet the requirements due to legal or financial constraints;

(4) An unconstitutional result;

(5) Transaction for all intents and purposes is an unrelated loan transaction.

Under Code Sec. 469, passive losses can only be used to offset passive income. Taxpayers who have losses from a passive activity cannot use losses from a passive activity to offset nonpassive income, such as wages. A passive activity generally is an activity in which a taxpayer does not “materially participate.” Passive losses that cannot be deducted must be carried over to a future year, where they can offset newly generated passive income.

Taxpayers with excess passive losses may seek to generate additional passive income by converting nonpassive income into passive income. The regulations under Code Sec. 469 (Reg. §1.469-2(f)(6)) include a “self-rental rule” to prevent taxpayers from creating artificial passive activity income that they could use to offset their passive losses.

Ordinarily, rental income is treated as passive income. However, the self-rental rule provides that income from a taxpayer’s rental activity from an item of property, is treated as not being from a passive activity if the property is rented for use in a trade or business activity in which the taxpayer materially participates. Income that is recharacterized as nonpassive income cannot offset passive losses.

For example

An example of the self-rental rule was addressed in Williams, CA-5, 2016-1 USTC ¶50,173. In Williams, the taxpayer owned a C corporation and materially participated in the corporation’s trade or business. The taxpayer also owned an S corporation that rented real estate to the C corporation. The taxpayer did not materially participate in the rental activity. The rental activity generated income, which the taxpayer treated as passive income and used to offset passive losses from other entities.

The court concluded that the self-rental rule applied to the S corporation’s rental of the real property. The taxpayer, the owner of the S corporation, materially participated in the business of the C corporation that rented the property. As a result, the income generated by the rental activity had to be recharacterized as nonpassive income under the self-rental rule, and could not be used to offset the taxpayer’s passive losses from other activities.

The IRS always urges taxpayers to pay their current tax liabilities when due, to avoid interest and penalties. Taxpayers who can’t pay the full amount are urged to pay as much as they can, for the same reason. But some taxpayers cannot pay their full tax liability by the normal April 15 deadline (April 18th in 2016 because of the intersection of a weekend and a District of Columbia holiday).

One alternative is to enter into an installment payment agreement with the IRS, where taxpayers agree in writing to make monthly payments to the IRS and to reduce their tax liability to zero over a reasonable period of time. The IRS may also agree to an installment payment arrangement for back taxes. Penalties and interest may continue to accrue, although the IRS may reduce the penalties. While the IRS is authorized to enter into a partial payment installment agreement for a portion of the taxpayer’s liability, the agency has been reluctant to do this.

Form 9465

Taxpayers who cannot pay the tax liability reported on their current income tax return should submit Form 9465, Installment Agreement Request, to the IRS, to request a monthly installment plan. A taxpayer who owes more than $50,000 should provide Form 433-F, Collection Information Statement, along with the request. Taxpayers can enter into different types of agreements, including:

A traditional agreement, where they agree to make their monthly payment by check, money order, or credit card;

A direct debit installment agreement, to make automatic payments from a bank account; or

A payroll deduction agreement, with payments made by the employer from a paycheck.

The IRS charges a user fee for entering into an agreement: $120 for a traditional agreement; or $52 for a direct debit agreement. Qualifying low-income taxpayers pay a fee of $43, regardless of the type of agreement. If the agreement is restructured (because of a change in the taxpayer’s financial condition, for example), or if the IRS terminates the agreement and then agrees to reinstate it, the IRS will charge a fee of $50.

The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) made permanent many popular but previously temporary tax breaks for individuals and businesses. The PATH Act also enhanced many incentives. These enhancements should not be overlooked in tax planning both for 2016 and future years. Some of the enhancements are discussed here. If you have any questions about these or other tax breaks in the PATH Act, please contact our office.

Business incentives

Code Sec. 179 expensing. The PATH Act made permanent the Code Sec. 179 $500,000 dollar limit and $2 million investment limit. For tax years beginning after 2015 these amounts are adjusted for inflation. The IRS has announced that 2016 will not see any increase in the $500,000 limit and only a slight rise to $2,010,000 for the investment limit.

Enhancements, for tax years only beginning after 2015, include allowing the Code Sec. 179 expense deduction for air conditioning and heating units. Additionally, the $250,000 limitation on the amount of Code Sec. 179 property that can be attributable to qualified real property is eliminated, with a corresponding removal of carryforwards of disallowed amounts.

Bonus depreciation. Under the PATH Act, bonus depreciation is available at its 50 percent level starting in 2015 through 2017. However, the bonus rate is reduced from 50 percent to 40 percent for property placed in service in 2018 and to 30 percent for property placed in service 2019, after which it sunsets (ending after 2020, in the case of certain noncommercial aircraft and property with a longer production period). Effective for property placed in service after 2015, bonus depreciation for qualified leasehold improvement property is replaced with a bonus depreciation deduction for “qualified improvement property” made to the interior portion of a nonresidential building whether or not the building is subject to a lease; and the improvement need not be made only more than three years after the building was placed in service.

Research tax credit. The PATH Act made permanent the research tax credit. Effective for tax years beginning after December 31, 2015, a qualified small business during a tax year may elect to apply a portion of its research credit against the 6.2 percent payroll tax imposed on the employer’s wage payments to employees. The research credit is also added to the list of general business credit components designated as “specified credits” that may offset alternative minimum tax (AMT) as well as regular tax.

Work Opportunity Tax Credit. The Work Opportunity Tax Credit (WOTC) is extended through December 31, 2019 by the PATH Act. The WOTC also is expanded and made available to employers that hire individuals who are qualified long-term unemployment recipients beginning work for the employer after December 31, 2015.

Film/TV/live theatrical productions. The special expensing provision for qualified film and television productions is expanded by the PATH Act to apply to qualified live theatrical productions. These productions must commence after December 31, 2015, and before January 1, 2017.

Incentives for individuals

Exclusion from gross income of discharges of acquisition indebtedness on principal residences. The PATH Act extended for two additional years (through December 31, 2016) the exclusion from gross income for discharges of qualified principal residence indebtedness. The provision also provided for an exclusion from gross income in the case of those taxpayers whose qualified principal residence indebtedness was discharged on or after January 1, 2017, if the discharge was pursuant to a binding written agreement entered into prior to January 1, 2017.

Code Sec. 25C credit. The PATH Act extended and modified the popular Code Sec. 25C credit for energy-efficient improvements. For property placed in service after December 31, 2015, the standards for energy efficient building envelope components are modified to meet new conservation criteria.

Teachers’ classroom expense deduction. The $250 annual limit for the now permanent above-the-line deduction for classroom expenses under the PATH Act is inflation-adjusted starting in 2016. Due to low inflation, the $250 limit will not rise for 2016. Starting in 2016, expenses for professional development are added to the list of eligible expenses.

Your tax planning needs to respond to changes in the tax laws. Please contact our office and we can discuss how these and other changes in recent tax legislation may impact your comprehensive tax planning.

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Disclaimer

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, Vernoia, Enterline + Brewer would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.
Vernoia, Enterline + Brewer, CPA, LLC
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